Tuesday, September 30, 2008

Professor Nouriel Roubini provides, in great detail, his take on the failed bailout bill as well as discussing the current state of the economic crisis and alternative measures that may help to begin to heal the banking system and the wider economy.

It now appears pretty obvious that in anticipation of yesterday's vote the Democrats built the smallest possible coalition on the guarantee that Republican leaders would deliver a comparable coalition on their side resulting in just enough (of course, now we know too little) votes to pass yesterday’s bill and no more.

This was, in effect, an attempt by both sides to reduce the collateral election year damage of voting in favor of an incredibly unpopular bill.

Given this level of high stakes strategic politicking, what are the chances of Congress actually passing a bailout bill before the election?

Today’s release of the S&P/Case-Shiller home price indices for July continues to reflect the extraordinary weakness seen in the nation’s housing markets with now ALL of the 20 metro areas tracked reporting year-over-year declines and ALL metro areas showing substantial declines from their respective peaks.

Further, there has been a notable re-acceleration of the price slide with the 10 city index dropping 1.09% just since last month.

Also, it’s important to keep in mind that today’s release was compiled using home sales data primarily from June and July, well in advance of the historic levels of financial collapse seen in August and September.

In all likelihood, today’s report sits on the threshold of a new and even more momentous wave of home price declines as the continued economic crisis and dramatically accelerating unemployment work to both crush consumer sentiment and force panicked mortgage lenders to continue to tighten their lending standards.

As the housing decline goes “Up-Prime” a larger and much more damaging population of homeowners will face historic levels of financial stress the outcome of which is, at the moment, very hard to calculate.

The 10 city composite index declined a record 17.49% as compared to July 2007 far surpassing the all prior year-over-year decline records firmly placing the current decline in uncharted territory in terms of relative intensity.

The following chart (click for larger version) shows the percent change to single family home prices given by the Case-Shiller Indices as compared to each metros respective price peak set between 2005 and 2007.

The following chart (click for larger version) shows the percent change to single family home prices given by the Case-Shiller Indices as on a year-over-year basis.

Additionally, in order to add some historical context to the perspective, I updated my “then and now” CSI charts that compare our current circumstances to the data seen during 90s housing decline.

To create the following annual charts I simply aligned the CSI data from the last month of positive year-over-year gains for both the current decline and the 90s housing bust and plotted the data with side-by-side columns (click for larger version).

What’s most interesting about this particular comparison is that it highlights both how young the current housing decline is and clearly shows that the latest bust has surpassed the prior bust in terms of intensity.

Looking at the actual index values normalized and compared from the respective peaks, you can see that we are still likely less than half of the way through the portion of the decline in which will be seen fairly significant annual declines (click the following chart for larger version).

The “peak” chart compares the percentage change, comparing monthly CSI values to the peak value seen just prior to the first declining month all the way through the downturn and the full recovery of home prices.

In this way, this chart captures ALL months of the downturn from the peak to trough to peak again.

As you can see the last downturn lasted 97 months (over 8 years) peak to peak including roughly 43 months of annual price declines during the heart of the downturn.

Notice that peak declines have been FAR more significant to date and, keeping in mind that our current run-up was many times more magnificent than the 80s-90s run-up, it is not inconceivable that current decline will run deeper and last longer.

I am completely shocked by what transpired yesterday not because the market plunged… it was bound to sink to unsettling lows at some point during this cataclysmic meltdown… but because Congress actually listened to constituents and made the morally correct choice with 95 of 235 Democrats and 133 of 198 Republicans voting in opposition to the massive Wall Street bailout bill.

Let’s not forget the depth and extent of the narrative of dire circumstances and certain and immediate collapse used by Bernanke and Paulson to hold members of Congress and, by association, all Americans hostage to this mega Wall Street bailout.

For that reason alone, no matter where you came down ideologically on the bill, it seemed that you had to accept that the bill would pass.

The Chairman of the Federal Reserve, the Treasury Secretary and the President of the United States specifically stated that the American economy, and more broadly the entire world financial system, would literally collapse should the bill not pass … and it doesn’t pass!

That’s surely a far cry from the days when minute and barely comprehensible Greenspan mutterings like “irrational exuberance” would instantly drop markets around the world… the Feds gravitas has clearly been played out.

To be fair, Wall Street is, more or less, still listening intently but I think the fact the Main Street and their political representatives were brought to the precipice by such traditionally important figures and instead of cowering and acquiescing to being fleeced, very boldly, flipped them one seriously fat bird has got to indicate something... though, to be honest I’m not quite sure what.

Are American’s overconfident? Do they posses some heretofore unforeseen and untapped mettle in the face of dire economic circumstances? Have they just simply collectively gone postal?!?! … I mean they just watched like 1 trillion dollars of stock market wealth go up in smoke in a single day!

Perhaps there is just one very large and very vocal legion of independent minded citizens out there that took to the phone fax and email in the days building up to this vote and scared the wits out of house members who already seemed all but doomed by an election season that looks set to punish incumbents.

Well, whatever the reason, it didn’t pass and it looks as if legislators will have a significantly harder time building coalitions to support a follow-up bill as legislators divide along party lines and the election rhetoric kicks into high gear.

Monday, September 29, 2008

Will the Paulson’s massive “catch-all” Wall Street bailout bill do the trick in stemming the panic and breaking the credit market logjam or will this maneuver simply go the way of the “Super SIV” or, worse yet, create more uncertainty and exacerbate an already difficult problem?

By now most of you have likely already either perused the mega-bailout bill or some summarizations of its features so I won’t dwell endlessly on each individual feature but rather draw your attention to a few points of interest in the bigger, more ironic picture.

First, the “Purpose” of the proposed bill (soon to be law) sets out goals that, aside from being couched in foolish election-season populist language, declares an intention that is both pious and purposefully deceitful.

The purposes of this Act are—

(A) protects home values, college funds, retirement accounts, and life savings;(B) preserves homeownership and promotes jobs and economic growth;(C) maximizes overall returns to the taxpayers of the United States; and(D) provides public accountability for the exercise of such authority.

The elites clearly take us for fools … perhaps rightly so, though I have to imagine that there is at least a small contingent among us who can see the irony, albeit subtle, in the notion of the largest taxpayer funded financial crisis bailout in human history “maximizing returns to the taxpayer”, “promoting job growth” and “preserving homeownership”.

Further irony, how about that 11th hour phone call to Warren Buffett by Congressional negotiators in desperate need of a confidence boost and reassurance that bailing out Wall Street is the right thing to do… a truly epic embarrassment.

Even further still, Senator John Kerry inadvertently hit on a great point of irony too when he suggested that ”[Voters] don’t want a bailout of Wall Street and neither do we. What we are talking about is not losing 3 million jobs in a matter of weeks.”

Yet, we have been watching unemployment simply skyrocket for eight straight months now and it will continue to skyrocket precisely for the reason that those being bailed out don’t feel even the slightest twinge of remorse about throwing workers overboard in order to maximize shareholder value.

All the more reason a taxpayer-funded bailout of private institutions is a clear perversion of our economic system.

Yet the most significant irony of all might be what happens in November.

I generally steer clear of direct political statements preferring instead to simply spur along some form of action whatever it may be and so today I ask just one thing.

Keep all of these foolish dealings fresh in your mind when you enter the voting booth … don’t vote for the incumbent and if you can’t get yourself to pull the lever for a party you oppose, simply leave the space blank.

The only way to get some balance back in the system is for tainted elitist and lazy career politicians to be sent packing.

Friday, September 26, 2008

This post combines the latest results of the Rueters/University of Michigan Survey of Consumers, the Conference Board’s Index of CEO Confidence and the State Street Global Markets Index of Investor Confidence indicators into a combined presentation that will run twice monthly as preliminary data is firmed.

These three indicators should disclose a clear picture of the overall sense of confidence (or lack thereof) on the part of consumers, businesses and investors as the current recessionary period develops.

Today’s final release of the Reuters/University of Michigan Survey of Consumers for September showed an unexpected jump in consumer sentiment with a reading of 70.3, but still remains fairly weak with a decline of 15.71% compared to September 2007.

The Index of Consumer Expectations (a component of the Index of Leading Economic Indicators) also increased to 67.2 remaining 9.31% below the result seen in September 2007.As for the current circumstances, the Current Economic Conditions Index improved but still remains near record lows at 75 or 23.39% below the result seen in September 2007.

As you can see from the chart below (click for larger), the consumer sentiment data is a pretty good indicator of recessions leaving the recent declines possibly predicting rough times ahead.

The latest quarterly results (Q2 2008) of The Conference Board’s CEO Confidence Index increased marginally to a value of 39, nearly the lowest readings since the recessionary period of the dot-com bust.

It’s important to note that the current value has fallen to a level that would be completely consistent with economic contraction suggesting the economy is either in recession or very near.

The September release of the State Street Global Markets Index of Investor Confidence indicated that confidence for North American institutional investors increased 0.9% since August while European confidence increased 5.4% and Asian investor confidence declined 2.5% all resulting in a decrease of 2.4% to the aggregate Global Investor Confidence Index which now rests 20.29% below the result seen last year.

Given that that the confidence indices purport to “measure investor confidence on a quantitative basis by analyzing the actual buying and selling patterns of institutional investors”, it’s interesting to consider the performance surrounding the 2001 recession and reflect on the performance seen more recently.

During the dot-com unwinding it appears that institutional investor confidence was largely unaffected even as the major market indices eroded substantially (DJI -37.9%, S&P 500 -48.2%, Nasdaq -78%).

But today, in the face of the tremendous headwinds coming from the housing decline and the mortgage-credit debacle, it appears that institutional investors are less stalwart.

Since August 2007, investor confidence has declined significantly led primarily by a material drop-off in the confidence of investors in North America.

The charts below (click for larger versions) show the Global Investor Confidence aggregate index since 1999 as well as the component North America, Europe and Asia indices since 2007.

I’ve been arguing for the better part of two years that although the traditional media and apparently general consensus has focused on subprime and other “toxic” mortgage products as the source for the credit tumult, the historic deterioration would by no means be limited to these “bleeding edge” products.

To be certain, I’m not arguing that prime borrowers will default with the same rates as their sub-prime or near-prime brethren but rather that each mortgage product will inevitably experience respective historic levels of defaults.

Before this massive housing and general economic contraction is complete, I expect to see new records set for prime defaults, be they prime-Jumbo ARM loans, prime-Jumbo fixed rate loans, prime-conforming ARM loans or prime-conforming fixed rate loans… we will see historic defaults across the entire spectrum of mortgage products.

Until recently, most of my reasoning was based on a cursory study of the other periods with higher than “normal” mortgage defaults.

Although there is significant debate about the true drivers of mortgage default, most individuals in default cite unemployment as the cause while other key instigators are: risky or insufficient household financial planning (high consumer debt and low/no savings), low-equity stake and housing depreciation, and simply general recession.

The key point to consider though is that while all of these factors have contributed to creating environments of high mortgage default in the past, our current circumstances make these past periods look like walks in the park.

So, if borrowers from past periods, many of whom would likely be considered “prime” borrowers today (fully documented income, large down-payment, fixed-rate loans, etc. etc.), experienced bouts of higher mortgage defaults, what are the chances that our current cohort of “prime” borrowers will not perform the same?

In an effort to prove out this conjecture, I will track, with a quarterly recurring post, the operating performance of one of today’s most celebrated “conservative” mortgage portfolio lenders, Hudson City Bancorp (NASDAQ:HCBK), to see how their borrowers perform over the course of this economic downturn.

Hudson City is now fully recognized as the “poster child” for safe prime-only mortgage lending, stringent underwriting standards and a CEO, Ronald Hermance, who’s frequent media appearances usually come with heaping portions of high praise and accolades.

It’s important to understand that although Hudson City’s average borrower has a reasonable LTV of 61.5%, they are still seeing a precipitous increase in loan defaults.

In fact, currently the average LTV of their non-performing loans (defaulted loans) is 69% so “prime” borrowers with 31% equity at the time of origination are now defaulting in steadily increasing numbers.

The following chart plots Hudson City Bancorp’s Non-Performing Loan Ratio (defaulted loans to total loan portfolio) since Q1 2004.

Notice that defaults have been on the rise since Q2 2006 while in Q2 2007 things really started to heat up.

But how does the growth in defaults of the Hudson City Bancorp “prime” portfolio stack up compared to other well know default rates?

The Following charts compare the Hudson City default rate to that of Fannie Mae and the MBAA foreclosure rate.

The top chart compares the normalized default rates since Q1 2004 while the lower two compare the same data since Q1 2007 in order to get a sense of the respective growth over these periods.

It’s important to keep in mind that although Hudson City is not experiencing the same ratio of defaults (Fannie Mae and the general MBAA rates are worse) the growth of prime defaults is comparable and, since Q1 2007, has even been substantially higher.

The key instigators in this growth of default is likely home price depreciation and unemployment both working together to bear down on “prime” homeowners as is shown by the following charts plotting the year-over-year percent change to the New York area S&P/Case-Shiller home price index against the Hudson City default ratio as well as the unemployment in New York and New Jersey since 2004.

I will continue to update this data in coming quarters in order to see how slumping home values and rising unemployment affect the performance of “prime” borrowers.

Barney Frank joins Charlie Rose to discuss his view of the causes of our current economic crisis and details of the massive Wall Street bailout.

Frank explains that if only the government buys and holds the junk financial assets (mortgage, HELOC, credit card, auto, and education debt securities) the credit markets would flow again and the government would inevitably turn a profit.

With the massive bailout bill soon to be law allowing all of Wall Street’s junk assets (mortgage, HELOC, credit-card, auto, school debt securities) being neatly shifted to the federal government’s balance sheet, when will the United States lose its triple-A credit rating?

Looking at the report more closely though it appears that much of the growth was fueled by unusually large increases in exports, unusually large decrease in imports (inverse… declining exports adds to GDP), an unusually large increase in disposable personal income (likely fueled by the tax rebate checks) and fairly strong government consumption expenditures.

Still, fixed investment, both residential and non-residential continued to come under pressure with residential investment declining 13.3% and non-residential experiencing only tepid growth of 2.8% weighed down by a 5.0% decline in equipment and software.

Thursday, September 25, 2008

Professor Karl Case was nice enough to send me a copy of the slide show from Monday’s lecture and I thought you all would find it interesting to peruse (good lunchtime reading!).

I wish I could also supply the quality elaboration on each slide that Professor Case provided during his lecture but possibly an alternative is to re-read his original post from August while paging through the slides.

With the credit market seizing up, the housing market setting news lows, the stock market under pressure, unemployment mounting and the federal government essentially in a state of panic with the president being forced to come clean and make an appeal for an angry electorate to support the biggest bailout in American history … the question today is… WHERE ARE WE GOING?

I’m going to add this to the rotation of recurring posts as I think it very clearly captures the trouble that the central bank has had in controlling interest rates since mid-2007.

These interest rates are for short term (30 day) commercial paper that is typically issued by corporations to “raise needed cash for current transactions”.

A key in reading these rates is to recognize that the AA non-financial is more highly rated than A2/P2 non-financial and that, in general, the AA non-financial tends to track the Federal Reserve’s target rate while the others typically track slightly higher.

Normally, the spread between the weakest quality paper (A2/P2 non-financial) and the highest (AA non-financial) is 15-20 basis points but as of the latest Fed posting, the spread has expanded dramatically to 409 basis points… truly a worrying sign.

The first chart shows the spread between the A2/P2 and AA non-financial while the lower two charts show the how all the short term commercial paper rates have tracked since 1998 and mid-2007 respectively.

Notice that prior to mid-2007, the Federal Reserve had been able to keep these rates fairly tight and in-line with the target rate but now we are seeing significant trouble.

In as sense, the current crisis has effectively erased all the rate cuts Bernanke has made this cycle and even added another 75 basis points.

It’s important to keep in mind that this stunning year-over-year decline is coming on the back of the significant declines seen in 2006 and 2007 further indicating the enormity of the housing bust and clearly dispelling any notion of a bottom being reached.

Additionally, although inventories of unsold homes have been dropping for well over a year, the sales volume has been declining so significantly that the sales pace now stands at an astonishing 10.9 months of supply.

The following charts show the extent of sales declines seen since 2005 as well as illustrating how the further declines in 2008 are coming on top of the 2006 and 2007 results (click for larger versions)

Look at the following summary of today’s report:

National

The median sales price for a new home declined 6.17% as compared to August 2007.

New home sales were down 34.5% as compared to August 2007.

The inventory of new homes for sale declined 23.5% as compared to August 2007.

The number of months’ supply of the new homes has increased 18.5% as compared to August 2007 and now stands at 10.9 months.

Regional

In the Northeast, new home sales were down 45.8% as compared to August 2007.

In the Midwest, new home sales were down 39.3% as compared to August 2007.

In the South, new home sales were down 24.4% as compared to August 2007.

In the West, new home sales were down 50.0% as compared to August 2007.

It’s very important to understand that today’s report continues to reflect employment weakness that is strongly consistent with past recessionary episodes and that this signal is now so strong and sustained that a contraction in the economy is fundamentally certain.

Historically, unemployment claims both “initial” and “continued” (ongoing claims) are a good leading indicator of the unemployment rate and inevitably the overall state of the economy.I have added a chart to the lineup which shows “population adjusted” continued claims (ratio of unemployment claims to the non-institutional population) and the unemployment rate since 1967.

Adjusting for the general increase in population tames the continued claims spike down a bit but as you can see, the pattern is still indicating that recession has arrived.

The following chart (click for larger version) shows “initial” and “continued” claims, averaged monthly, overlaid with U.S. recessions since 1967 and from 2000.

NOTE: The charts below plot a “monthly” average NOT a 4 week moving average so the latest monthly results should be considered preliminary until the complete monthly results are settled by the fourth week of each following month.

In the above charts you can see, especially for the last three post-recession periods, that there has generally been a steep decline in unemployment claims and the unemployment rate followed by a “flattening” period of employment and subsequently followed by even further declines to unemployment as growth accelerated.

This flattening period demarks the “mid-cycle slowdown” where for various reasons growth has generally slowed but then resumed with even stronger growth.

So, looking at the post-“dot com” recession period we can see the telltale signs of a potential “mid-cycle” slowdown and if we were to simply reflect on the history of employment as an indicator of the health and potential outlook for the wider economy, it would not be irrational to conclude that times may be brighter in the very near future.

But, adding a little more data I think shows that we may in fact be experiencing a period of economic growth unlike the past several post-recession periods.

Look at the following chart (click for larger version) showing “initial” and “continued” unemployment claims, the ratio of non-farm payrolls to non-institutional population and single family building permits since 1967.

One notable feature of the post-“dot com” recession era that is, unlike other recent post-recession eras, job growth has been very weak, not succeeding to reach trend growth as had minimally accomplished in the past.

Another feature is that housing was apparently buffeted by the response to the last recession, preventing it from fully correcting thus postponing the full and far more severe downturn to today.

I think there is enough evidence to suggest that our potential “mid-cycle” slowdown, having been traded for a less severe downturn in the aftermath of the “dot-com” recession, may now be turning into a mid-cycle meltdown.

Although this continued falloff in demand is mostly as a result of the momentous and ongoing structural changes taking place in the credit-mortgage markets, consumer sentiment surveys are continuing to indicate that consumers are materially feeling the strain of the current economic weakness which will likely result in even further significant sales declines to come.

Furthermore, we are continuing to see SOLID declines to the median sales price for both single family homes and condos across virtually every region.

As usual, the NAR leadership continues suggesting that the massive government intervention into the marketplace will translate to a boon for their industry.

“August sales reflect higher interest rates before the government takeover of Freddie Mac and Fannie Mae, and the sudden drop in mortgage interest rates over the past couple weeks is improving housing affordability, … However, home sales will be constrained without a freer flow of credit into the mortgage market. The faster that happens, the sooner we’ll see a broad stabilization in home prices that in turn will help the economy recover, … Historically, housing has led the nation out of economic doldrums – there will not be an economic recovery without a housing recovery.”

Yun forgets to mention that the government bailouts and housing initiatives will cost taxpayers literally hundreds of billions of dollars placing a historic burden on industry and workers and seriously restraining economic growth.

Keep in mind that these declines are coming “on the back” of TWO SOLID YEARS of dramatic declines further indicating that the housing markets are truly in the process of a tremendous correction.

The following (click for larger versions) are charts showing sales for single family homes, plotted monthly, for 2006, 2007 and 2008 as well as national existing home inventory and month supply.

Below is a chart consolidating all the year-over-year changes reported by NAR in their most recent report.